Solvent Exit Planning for Non-Systemic Banks and Building Societies
An overview of Solvent Exit, the proposed new requirements, and key considerations for firms
In late June 2023, the Prudential Regulation Authority (PRA) published its Consultation Paper (CP10/23) on Solvent Exit Planning for Non-Systemic Banks and Building Societies.
Whilst the concept of wind down is not new within the regulatory landscape, with trading book wind down being the most recent high-profile focus area, the requirement for capabilities to be in place in BAU is new for the majority of this cohort of firms.
This blog provides an overview of Solvent Exit, the proposed new requirements, and key considerations for firms to consider in their implementation.
The below diagram details how solvent exit planning fits in with other relevant planning policies for both systemic and non-systemic firms:
“A solvent exit means the process through which a firm ceases PRA-regulated activities (deposit-taking) while remaining solvent throughout to the point that they can be liquidated safely and repay all depositors and creditors in full. The firm should transfer or repay (or both) all deposits as part of its solvent exit. Once the firm has transferred and/or returned all deposits, a solvent exit will end with the removal of the firm’s Part 4A PRA permission”
− PRA Consultation Paper 10/23
This consultation is relevant to a firm that is a non-systemic UK bank or building society. For the purpose of solvent exit planning, the PRA defines this as a UK bank or building society that is:
a. not subject to the Operational Continuity Part of the PRA Rulebook, or
b. not part of a global systemically important institution (G-SII) or another systemically important institution (O-SII), according to Chapter 7 of the Recovery Plans Part of the PRA Rulebook.
Furthermore, it is not relevant to credit unions or branches of third-country groups.
The requirement for “New Banks” to develop solvent exit plans is an existing condition of authorisation. The guidance set out in the consultation should support these firms in formalising their solvent exit plans by providing further detail on expectations.
There are broadly three phases for firms to consider regarding implementation, including what elements need to be in place in BAU followed through to practical execution of a solvent exit.
The below diagram practically denotes maintaining an up-to-date solvent exit plan in BAU based on a generic scenario with scenario-agnostic elements kept populated. The rationale lies on the presence of a “reasonable prospect” before preparing a detailed plan, which if starting from scratch will now allow for a timely recommencement. Hence, the importance of a living document is being highlighted herein, which if continually maintained and enhanced as part of regular governance and business as usual, capabilities are ensured in case of a need for an orderly solvent exit.
Throughout implementation, it is important for firms to be aware of common challenges and pitfalls associated with both the planning for, and actual execution of, a wind-down – a topic we have previously provided insight on “Wind-Down Plans Unwrapped”.
Below we have documented selected further key considerations and practical lessons learned for firms to consider as part of implementation.
− Conservative trigger frameworks
Our prior experience of supporting firms in both the planning and actual execution of wind downs demonstrated that a protracted timeline to exit increases the risk of a disorderly outcome. Triggers used should be forward-looking in nature and calibrated to allow the exit to be undertaken in a solvent manner. This requires developing an understanding of potential resolution and / or insolvency triggers.
Therefore, firms need to develop conservative, forward-looking triggers for initiating the development and actual implementation of an execution plan while there is a reasonable prospect of success.
− Financial modelling
It is important as part of the planning phase in BAU to identify the key drivers of cost and uncertainty as part of a solvent exit, which will likely contain some idiosyncrasies depending on business models.
The financial modelling of the wind-down period is therefore a crucial element that the regulator may focus on. It is important as part of the planning phase in BAU to identify the key drivers of revenue, costs, and funding, and to consider how these may be impacted in a wind-down scenario. Ultimately, firms will need to demonstrate that they have considered the required levels of capital, liquidity, and funding to ensure that they could achieve a solvent wind-down.
This financial analysis would need to reflect relevant prudent planning assumptions made during the firm’s wind-down analysis. Examples of these include the potential haircut on sales and incorporating the associated costs to support the solvent exit, including amongst other elements, external advisors.
− BAU capabilities, frameworks, and documentation
To aid preparedness and to provide the regulator with comfort of readiness to support a timely and orderly outcome, firms should develop and maintain a framework to deliver a Solvent Exit Execution Plan in a timely and robust manner.
We have seen good practice as having support materials included within the Solvent Exit Analysis itself, to ensure it will be continually maintained and enhanced as part of a regular governance. This may include elements such as an annotated skeleton of an execution plan, with scenario agnostic elements (e.g. business lines, staff) pre-populated to support timely development.
− Integrating Recovery and Resolution Planning
When considering the implementation of solvent exit planning, there is the potential to demonstrate further integration with recovery and resolution planning, rather than create a new independent set of capabilities. For example, the development of a solvent exit analysis in BAU should support enhanced recovery capabilities. Another example is the potential to leveraging the Single Customer View (SCV) to better understand likely deposit behaviour during a solvent exit.
Furthermore, another key example is in relation to an embedded and consistent trigger framework across the set of capabilities. This is emphasised in the CP and may include quantitative and qualitative indicators of when you would expect to commence recovery planning, the commencement of a solvent exit and any potential resolution trigger. One interesting consideration for firms is whether to align the commencement of recovery planning with beginning to develop the solvent exit execution plan.
− Scenario analysis
As part of BAU implementation, firms are encouraged to identify scenarios which could lead to the consideration of solvent exit being a reasonable prospect (and thus require the development of an execution plan). Firms should consider this through the lens of both financial distresses, as well as operational issues.
It is also important for firms to consider a scenario where a solvent exit may not be possible, such as in a fast-failure scenario, including a consideration of what a shortened timeline may mean for planning. This is consistent with the future direction of Recovery and Resolution Planning, with numerous firms moving towards preparing for a fast failure scenario, in the context of recent events.
− Testing and Assurance
A key consideration for firms is the ability to provide comfort to both senior management and the regulator that capabilities, documentation, and frameworks in place are sufficient to execute an orderly solvent exit.
Whilst it is important for firms to take a scenario-agnostic approach to implementation, there will be commonalities across scenarios leading to a solvent exit which could be tested – for example, if communication infrastructure is fit for purpose. Examples of testing exercises may include the population of an execution plan based on a specific scenario, through to more holistic senior management exercises which test the decision-making, governance, and monitoring of when to begin planning for and actual execution of a solvent exit.
− Group Interaction
Another important consideration aimed at international banks is the overreliance on Group as a key vulnerability when it comes to executing an orderly solvent exit. Firms should therefore interrogate their interdependencies and complexities with their parent entity, highlighting potential ways of minimising reliance on Group support and planning to work towards financial and funding independence.
Conclusions
Whilst firms are encouraged to leverage existing capabilities where appropriate, it is important to note that this is only a starting point, with the consultation likely requiring a material uplift in capabilities, including the need to produce and maintain a solvent exit analysis.
As the experience of recent market events demonstrate, it is important that the regulator has flexibility and optionality for firms to exit the market in an orderly manner.
Firms having the ability in BAU execute an orderly solvent exit provides this further optionality and compliments the toolkits already in place associated with Recovery and Resolution Planning.
The Consultation runs until 27 October 2023, with the implementation date for the changes resulting from this CP expected to be in Q3 2025.
